The reason we’ve got a PAYE tax system: because we don’t notice them taking it

THERE is a good reason why we’ve got a tax system that hoovers the cash out before you see it. No, it’s not because it’s convenient. It’s because we don’t really notice how much it is:

Cabral and Hoxby find that when property taxes are less salient, people tend to be less aware of the amount they pay and when people are less aware, property tax rates tend to be higher.

How do they get variation in salience? By looking at the percentage of people who pay their property taxes with tax escrow, that is, bundled with their mortgage payments. Check out their Figure 7 (page 55 in the ungated version) for a striking graph. The standard deviation of the difference between the property tax reported in surveys and actual tax paid was $2215 for people who used tax escrow and only $781 for people who did not.

Agreed, that’s about property taxes in the US. But the same point holds for income tax (and even more for national insurance, where supposedly “the employer” pays some of it but the real effect is to lower our wages). By taking it before we get ahold of it the government is able to take more of it. The bastards. Because we just don’t notice it so much.

Weirdly, this system was invented by Milton Friedman. No, really.

There’s one other interesting little point. So far as I know the only complete tax system where you actually have to turn up and cough up the taxes well after you’ve been paid is Hong Kong’s. And they do have a very low income tax rate.

It’s also worth pointing out perhaps that it tends to be the self-employed who whine about tax rates a lot more than those paid through PAYE. Because the self-employed do have to write out a cheque for the money: it doesn’t get taken at source.

In short, the reason they tax us this way is so that we don’t notice how much we’re being taxed.